Jeff Clark's Market Minute

The Best Strategy for LEAPs

Happy Friday.

In today’s mailbag, I’m going to answer a question about LEAPs (long-term equity anticipation securities). Simply put, LEAPS are long-term options. And, for whatever reason, I’ve been receiving a lot of questions about them recently. Such as…

Why don’t you ever recommend LEAPs (long-term options)? You’re a short-term trader, but surely you have some long-term ideas. Wouldn’t using LEAPs be a good way to trade those ideas?

 Roger

Thanks for the excellent question, Roger.

Yes, I do have some longer-term ideas. For example, I’m quite confident the gold sector will be higher one year from now than where it is today. And I think most automobile stocks will be lower. I’ve often thought that if I simply buy long-term call options on gold stocks, and long-term put options on auto stocks, then I could fall asleep for a year and wake up to really nice profits.

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But there are two problems with that kind of thinking…

First off, I can’t fall asleep for a year. So, I’m going to be watching the market every day it’s open for trading. And I know myself well enough to know I can’t possibly watch the action and avoid the temptation to trade for an entire year. It’s just not in my character.

Secondly, in every long-term trend there are multiple short-term, counter-trend moves. Sitting through those counter-trend moves is emotionally difficult to do. And it is often expensive.

As a trader, I prefer to trade my long-term ideas through a series of short-term positions rather than one long-term trade.

Here’s what I mean…

I’ve been bullish on gold stocks all year. At the beginning of 2017 I was quite confident that the VanEck Vectors Gold Miners Fund (GDX) would be higher by the end of the year. GDX started 2017 at $22 per share, and the GDX January 2018 $22 calls were $2.70.

Today, GDX is just over $24 per share. But, because of the time decay of the option, the GDX January $22 call is trading for $2.90. An owner of this LEAP has only made $0.20 per share so far.

But, here’s the thing…

During this longer-term uptrend, GDX has had four concentrated rallies and four counter-trend declines. Any trader who took some profits off the table during the rallies, and then bought back the positions during the declines, would have far greater profits than just $0.20 per share.

In my Delta Report newsletter, we’ve been in and out of GDX five times so far in 2017. Each time was profitable, and we’ve recorded a total of $4.25 per share in profits. That’s a whole lot better than the $0.20 gain we’d have if all we did was buy the GDX LEAPs and then go to sleep.

There is, however, one strategy for which I do like to use LEAPs…

Traders who are familiar with the strategy of selling covered call options against their stocks – as a way to generate income – can do far better by owning long-term calls instead of the actual shares of stock and then selling short-term calls against the long-term position.

For example (this is just an example, not a recommendation), let’s say you own Intel (INTC) right here at about $36.50 per share. You can sell the INTC January $37 call options for $1.30 and collect $130 of income for every 100 shares you own. If you can do that every three months for a year, then you’ll generate $520 of income on each 100 shares of INTC. That’s more than 14% per year on your shares.

But with LEAPs you can do better.

Instead of buying shares of INTC, you can buy one INTC January 2019 $35 call option for $4.20. Then, you can sell the same covered calls you would sell on the stock against your LEAP position instead. Since you’re putting up less money to buy the LEAP than you would to buy the stock, the potential return from a covered call strategy is much higher.

There’s a little more to the strategy than I can explain in a brief essay (like where the stock will be at expiration, the dividend policy of the underlying stock, implied volatility of the options, etc.). But, in general, using LEAPs instead of stock for a covered call strategy can significantly enhance returns.

For the most part, this is the only strategy in which I’ll use LEAPs.

Would you consider adding a new portfolio page of your Delta Direct suggestions? I have a position in UUUU energy systems that I believe came out of one of your posts. But I can't find it now. It is very difficult to find those types of recommendations with all your posts. Maybe start including the ticker in the subject line when you talk about a stock.

 Ron

Hi Ron, thanks for your suggestion.

Several weeks ago, the Tech Wizards added a search function to the Delta Report webpage. It’s at the top right hand side of the page. You can type in whatever ticker symbol you’re looking for and the results will show every post I’ve made that included that symbol.

We exited the UUUU trade when the stock popped higher on July 19.

Your suggestion to add a portfolio page for Delta Direct makes sense to me. I’ll ask the Wizards to get to work on it.

Best regards and good trading,

Jeff Clark

P.S. If you have a question or suggestion you’d like featured in our Friday mailbag issue, send it to me right here.

Jeff’s intuitive feel for short term market swings and his strong protective discipline have allowed me to lock in thousands of dollars in gains where I might otherwise have just ridden the markets up and down .”  -Chris, a reader and “seasoned investment advisor” from Seattle

Jeff -- your picks and analysis have been nothing short of amazing. I have traded the market for many years but I must admit, I have NEVER seen something this good.” - Mike H.

In only 2 weeks of using the service I’ve booked over $10K in profits. Needless to say I’ve paid for my membership.” - Tony J.

I started following Delta Direct about 3 weeks ago… I bought a small investment from one afternoon to the next morning. About 11AM I got out and made 8K in less than 24 hours.” – D. Tilghman